Lower bound : American call

mehak.officiallink
Good Student
Posts: 31
Joined: Sat Mar 08, 2014 6:59 am

Lower bound : American call

Postby mehak.officiallink » Sun Oct 12, 2014 1:44 pm

Lower bound for american call :
Max(0, S-X/(1+r)^t)
The doubt is that american option can be exercised immediately, then why are we discounting X ?
Why is it simply not S-X ?

edupristine
Finance Junkie
Posts: 722
Joined: Wed Apr 09, 2014 6:28 am

Lower bound : American call

Postby edupristine » Mon Oct 13, 2014 5:38 am

Though American option can be exercised immediately, there is always a possibility that it is exercised after some point of time in anticipation of higher returns. And hence, it is appropriately discounted at the risk free rate.


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